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Building an Honest Microfinance Organization: Embezzlement and the Optimality of Rigid Repayment Schedules and Joint Liability

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  • Doh-Shin Jeon
  • Domenico Menicucci

Abstract

We consider the agency problem of a staff member managing microfinancing programs, who can abuse his discretion to embezzle borrowers' repayments. The fact that most borrowers of microfinancing programs are illiterate and live in rural areas where transportation costs are very high make staff's embezzlement particularly relevant as is documented by Mknelly and Kevane (2002). We study the trade-off between the optimal rigid lending contract and the optimal discretionary one and find that a rigid contract is optimal when the audit cost is larger than gains from insurance. Our analysis explains rigid repayment schedules used by the Grameen bank as an optimal response to the bank staff's agency problem. Joint liability reduces borrowers' burden of respecting the rigid repayment schedules by providing them with partial insurance. However, the same insurance can be provided by borrowers themselves under individual liability through a side-contract.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 272.

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Date of creation: Jan 2006
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Handle: RePEc:bge:wpaper:272

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Keywords: Microfinance; Contract; Embezzlement; Insurance; Joint Liability;

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  1. Conning, Jonathan, 1999. "Outreach, sustainability and leverage in monitored and peer-monitored lending," Journal of Development Economics, Elsevier, vol. 60(1), pages 51-77, October.
  2. Gale, Douglas & Hellwig, Martin, 1985. "Incentive-Compatible Debt Contracts: The One-Period Problem," Review of Economic Studies, Wiley Blackwell, vol. 52(4), pages 647-63, October.
  3. Ghatak, M. & Guinnane, T.W., 1998. "The Economics of Lending with Joint Liability: Theory and Practice," Papers 791, Yale - Economic Growth Center.
  4. Faure-Grimaud, Antoine & Laffont, Jean-Jacques & Martimort, David, 2003. "Collusion, Delegation and Supervision with Soft Information," IDEI Working Papers 167, Institut d'Économie Industrielle (IDEI), Toulouse.
  5. MkNelly, Barbara & Kevane, Michael, 2002. "Improving Design and Performance of Group Lending: Suggestions from Burkina Faso," World Development, Elsevier, vol. 30(11), pages 2017-2032, November.
  6. Armendariz de Aghion, Beatriz, 1999. "On the design of a credit agreement with peer monitoring," Journal of Development Economics, Elsevier, vol. 60(1), pages 79-104, October.
  7. Ghatak, Maitreesh, 1999. "Group lending, local information and peer selection," Journal of Development Economics, Elsevier, vol. 60(1), pages 27-50, October.
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